erol,
I'm glad you raised this question. Spin (whom you already know is pretty knowledgeable about options) is referring to the spread in the prices on the options chains and not paying a poor price for the whole package.
To really outline this for you, I went and looked up the prices for the three options (quoted on yahoo finance for the close today, which may or may not be completely accurate)
All the options are March 10 puts (the same ones you had a butterfly on)
Prices: 100P $0.70-$1.40
105P $1.90-$3.40
110P $4.00-$8.00
In order to calculate a "good" price, we split each price at the midpoint between the bid and the ask , which gives us:
100 mid $1.05
105 mid $2.65
110 mid $6.00
Then the price for the butterfly is calculated by adding the 110 and 100 calls and subtracting 2*the 105 calls.
($6.00+$1.05)-(2*2.65)=$1.75
This means that if you bought or sold this butterfly at the "mid" all the way across, you would pay or get $1.75. (By the way, our friends at thinkorswim make this information available as you do the order) If you managed to obtain a price close to this you would be doing well. In the practical world of real trading, you probably would need to pay somewhere close to $2.00 in order to buy this and obtain about $1.50 if you sold this. (Market makers really like to be nicely compensated for their risks, too)
One thing I note as I look at the chains for LQD. The bid ask spreads are pretty wide and both the volume and open interest are relatively small. This means that you are likely to be trading more on the market makers terms than you will probably like, and probably paying well over $2.00 for this spread on entry. This is not too horrible (but not desirable, either) if you choose a directional strategy, which will either win noticeably or lose noticeably, particularly a strategy that is a good winner if it expires worthless. Then you will only will 'lose' on the spread when you enter.
If, however, you choose to buy a standard butterfly, it is a loser if it expires worthless. If it is in the money, then you will have to take some action to obtain your profits, probably selling the butterfly, obtaining a price noticeably less than the mid to do so. An important consideration when trading an instrument such as this is that in order to profit, you must overcome this factor at least on the entry, and if you close it there as well. Most traders call this factor slippage.
Now to share my personal opinion. If you are absolutely convinced that you have an insight that the market is overlooking, you can do well despite this. Several years ago, I had a very strong hunch that a particular company was not doing very well and would be overwhelmed by its competition in fairly short order. I sold a lot of bull call spreads (at the time, I was not allowed to sell calls naked). It appeared to be a risky transaction, and the volume in these options was not very big. It was practically the only transaction in the options chain that day, and I would have been at the mercy of the market maker if I had been wrong.
However, it turned out that my insight was very accurate. Before the options expired, the company went belly up, leaving me to pocket the entire amount that I had written.
On the other hand, nowadays, I generally do not favor trading in illiquid options because the slippage is high. I would rather trade options that are very liquid with smaller slippage and not have to overcome it.
